EURUSD knocked back to the mat as Spanish yields swoon

EURUSD got a bit of a nosebleed above 1.2600. The approaching ECB meeting on Thursday is the key test for short term EURUSD sentiment – is about EU tail risks any more or is it all about devaluation?

The USA gets back down to business today after the Monday Labor Day holiday marks the official end of summer for North America, a date that often coincides with the UK (school starting up this week) and the rest of Europe coming back from its long August vacations. As such, this week is a critical one in seasonal terms, something I highlighted with a long piece I penned yesterday on the last 10 Labor Day Weeks and charts on the last nine. In all but perhaps two cases of those ten, it’s arguable that the week was important for setting the tone for the rest of the year.

Key shift in Euro themes?As I have argued previously, much of the recent rally in Euro crosses has to do with the unwinding of tail risk (bets that an EU breakup/banking crisis is in play here and now) and excess positioning. With Draghi’s mention yesterday of the ECB being willing to consider buying 2-3 year bonds at the periphery, the cat has half-emerged from the bag ahead of the ECB meeting. The other remaining issue that must be addressed at the meeting is the issue of capital flight, as capital is fleeing Spain at an alarming rate

Most interesting is the market’s reaction to the Draghi developments: late yesterday, EURUSD tacked on some additional gains on the news, but the single currency was weaker today, suggesting that we may be seeing a transition away from the EURUSD finding support on news that impacts the tail risk trade. It is still too early to tell this as we remain in the recent range, but that shift is one that I expect one way or another in the coming weeks – with the maximum wait being until shortly after the other side of the FOMC meeting next Wednesday. Technically, the EURUSD rally will only really be in trouble if it transitions back below 1.2450.

AUD – shrugging off the RBAThe RBA statement was much scrutinized for clues on the whether the RBA will likely cut again, with some suggesting that the downgrade in language on China means that the RBA would like to stay open for another 50 basis points of cuts in the near term should the situation in China and domestically continue to deteriorate, while others suggest that the RBA would like to pause as long as possible here. The forward expectations are looking for a almost 100 bps of further easing from here and were not shifted much by the RBA meeting overnight.

The long AUD position was very extreme at the peak of the most recent cycle and there may be very considerable further downside to go yet for the currency if risk appetite fails to catch a bid after the US FOMC meeting. Gold and risk appetite are the two crutches for Aussie that must be the focus in the days and weeks ahead. As long as AUDUSD remains below its 200-day moving average (currently about 1.0315), the outlook is negative.

Looking aheadThis round of Manufacturing PMI’s from around the world has been far from impressive, with more somber data out of the Europe and Asia and the US data point up shortly today. Tomorrow we have world non-manufacturing PMI day (ex USA, which reports Thursday due to Labor Day holiday.) China’s services PMI remains resilient, which is worth noting, but the manufacturing data weighs more heavily in my mind there (also, the unofficial HSBC Services PMI for China is up tonight – worth comparing to the official data). It’s doubtful that Europe will post anything interesting on the services front, but the US data point and the employment report on Friday will be very interesting as the final major data points ahead of next Wednesday’s FOMC meeting.

Before then, of course, we have the ECB meeting on Thursday. It appears that the Bundesbank’s Weidmann is entirely isolated now in his position on European bond buying. Will he be overruled? The market seems to be making that bet.

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